Equity Mutual Funds vs Stocks: Where to invest?

Date :
13/07/2018

Read: 6 mins

Should you invest in direct equity or equity mutual fund? This article will clear all your doubts and help you make an informed decision

The equity markets hit an all-time high on July 12 with the 30-share Sensex and 50-share Nifty scaling above 36,500 and 11,000-mark, respectively. Those who are already invested in the market are enjoying this bull run, but then there are those who are still waiting for the right time. The basic question that troubles them is – should they be investing in direct equities or mutual funds?

New investors often can’t seem to decide which is more suitable. If you are one of the fence-sitters, you should first understand the difference between the two.

Stocks vs Mutual Funds

A stock, also known as ‘share’ or ‘equity’, is an instrument that companies sell in the open market – i.e. to you – to raise funds to finance their operations. Buying shares means you are buying part ownership in that company, and therefore have a claim in its future earnings. The amount payable to you depends on the number of shares you buy. Later, you can sell them and make a profit – or a loss, if you are forced to undersell.

A mutual fund is a product that pools money from a lot of people – who then become its shareholders – to invest in securities such as company stocks/equity. Funds also buy bonds, short-term debt etc. If you decide to invest in these, you are buying shares inthatspecific mutual fund, not in the company per se.

People often invest in equity mutual funds (EMFs) through the Systematic Investment Plan (SIP) route, in which a fixed amount is put in a fund in equal instalments over a fixed timeframe.

Of course, there are also those who invest in equities directly, as they do not want to pay the ‘expense ratio’ which mutual fund companies charge to cover operating costs. This expense ratio is generally around 2-2.5% of the assets under management; saving on this ensures more returns for the investor.

But remember, investing directly can be risky for people who are just starting out. Building and tracking a diversified stock portfolio requires a level of expertise. Moreover, the time and energy needed for this exercise is generally more than most people can afford.

If you are a newbie, you will do well to go via EMFs because this ensures both expertise and diversification. Mutual funds are professionally managed, and as financial experts decide where to invest, risks associated with investing in stocks on your own are lessened. Moreover, a single EMF will invest across an array of stocks – or a ‘diversified portfolio’ – to reduce risk.

Fund returns

As already stated, equity markets can get overwhelming for newcomers given the complexities involved, which makes mutual funds and the SIP route more desirable. But there’s another argument in favour of funds: better returns.

When discussing investing, returns is the first thing that crosses the mind. But how does it differ between investing in stocks and mutual funds? While there are exceptions, most actively managed mutual funds outperform the benchmark index over long periods.

Here’s a table comparing the average performance of top five large cap EMFs with the Nifty 50 over the past five years. Nifty 50 has given 14.78% returns in the past five years.

Fund name

Fund returns over the past five years

Excess returns

JM Core 11 Fund

20.49%

5.71%

Reliance Large Cap Fund

19.45%

4.67%

SBI Bluechip Fund

18.58%

3.80%

Aditya Birla Sun Life Focused Equity Fund

18.10%

3.32%

ICICI Prudential Bluechip Fund

17.44%

2.66%

(Note: Data as on July 10, 2018; Source: Value Research)

The stock edge

However, there are two aspects where stocks score. We have already touched upon one – the cost of investment; this clearly goes in favour of stocks, their only cost being the brokerage you pay when buying or selling.

Also, direct equities are more transparent since you invest after doing thorough research. Maintaining a direct equity portfolio gives you the flexibility to hold or sell as per your views in the market. While equity-linked saving scheme (ELSS) mutual funds come with a lock-in period, (minimum 3 years) but they provide tax benefit under Section 80C of the Income Tax Act.

It is this flexibility that critics of the SIP route harp on. In their view, while investing in a mutual fund may seem very simple at first glance, this mode has its limitations. They feel it is unlikely that funds giving above-average returns over a five-year stretch will continue to do so indefinitely; it is entirely possible that a fund that gave the best returns during 2011-2016 may falter during 2016-2021.

By comparison, investing in a well-researched and diversified stock portfolio, under the guidance of a qualified financial advisor, can yield better-than-benchmark returns. And you can look at the entire canvas of listed stocks to invest in – be it large-cap, mid-cap or small-cap: fundamentally sound stocks yield returns irrespective of company size.

Take for instance the period from January 29 of this year, when the BSE Sensex hit a high of 36,443 points before selling pressures pushed it down, till date July 12, when bulls pushed it up to the same level again.

During the period, Indiabulls Ventures (small-cap) rose over 50% to give returns of 84.91%, Mphasis (mid-cap) rallied between 10% and 30% to yield 32.2% returns and Britannia Industries among large-cap gave 36.29%. Moreover, on July 13, the Sensex scaled a new high of 36,740 points, and in intra-day trading, as many as 22 stocks rose between 30% and 80% to outperform it.

Therefore, while mutual funds are comparatively a safer bet, investing in direct equities can give you better returns. You can take a call based on your risk appetite.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.